Will inflation rise see interest rates go up?

Under normal circumstances, today’s inflation figures would very likely be the precursor to a rise in interest rates this Thursday.

Whenever the headline rate of inflation strays one percentage point either side of the 2% rate that the Bank of England’s Monetary Policy Committee (MPC) is mandated to target, the Governor is obliged to write to the Chancellor, explaining why.

With the consumer prices index at 2.9% in August, we are moving close to letter-writing territory.
The chances are, though, that the MPC will continue to sit on its hands this week. The majority of its members have, during the last year, chosen to ‘see through’ the recent rise in inflation and treat it as a temporary phenomenon caused by the devaluation in the pound following the vote to leave the EU last year.
:: Inflation hits 2.9% as fuel and clothing costs grow
Mark Carney, the Governor, has also made clear on a number of occasions his concerns about the impact Brexit is likely to have on the economy.
He strongly believes it is going to hit growth for a number of years and this is another reason why he has been so adamant that rates must stay lower for longer.
The recent fragility in consumer spending is just one of a number of indicators that suggests the economy is losing momentum.

That devaluation in the pound is certainly one of the main causes for the rise in inflation last month. Another, though, is the rally in the oil price which saw crude trading above $50 per barrel for most of August. It is currently back to levels last seen in mid-May.

Image: Mark Carney, Bank of England governor, strongly believes Brexit will hit growth
The MPC’s expectation is that, towards the end of the year and into 2018, inflation should abate as the impact of the drop in the pound last year is ‘lapped’ and sterling-related price increases start to drop out of the year-on-year comparison.
But there is no doubt that the pressure for an interest-rate rise is starting to build, as can be seen by the rise in the pound today on foreign exchange markets. Sterling has not traded at this level against the US dollar since 13 September last year, before the so-called “flash crash” that briefly saw it tumble on Far Eastern markets to $1.145. Against the euro, the best-performing currency among advanced economies this year, sterling’s rally has been less spectacular.
Ironically, this recovery against the US dollar may go some way towards providing insulation against further price rises, since the greenback is the currency in which most international commodities used by manufacturers are priced.
Yet it will also have the effect of blunting the improvement in competitiveness that Britain’s exporters have enjoyed as a result of sterling’s devaluation.
The dog that has not barked in all this is wage inflation. In spite of the jobless rate standing at a 42-year low, which ordinarily would spark a rise in wage inflation, earnings growth has stagnated.
Until such time as earnings growth picks up – and perhaps the Government’s decision to loosen its 1% cap on public sector pay rises may speed that process up – the MPC is likely to hold off raising the cost of borrowing.